The "Enbridge Pill" Will Cure These Canadian Oil Producers

Nathan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The Spread Problem

The unconventional oil boom in North America could hardly be forecast only a few years ago. However, Canadian oil players haven't benefited much from this boom in 2012 due to the spread between WTI and Edmonton light crude prices. Pipeline constraints, in conjunction with the constraints of refinery capacity in the US Midwest, have negatively impacted the Edmonton price, broadening the discount with WTI during 2012. This spread hit $20 a couple of months ago, and it was around $10 on average last year, hurting both the Canadian oil producers and the Canadian economy. 
 
The "Enbridge Pill"
 
This discount is expected to decrease in Q2 of 2013 as refineries go online. However, the biggest decrease will occur once Enbridge (NYSE: ENB) completes its two projects in 2013: the Seaway expansion and the "light oil access program." To me, these projects are game changers. The Seaway pipeline expansion from 150,000 bopd to 400,000 bopd will be completed in Q1 2013, and there is a twin line planned for 2014 that will further boost capacity to 850,000 bopd. This project will primarily narrow the spread between WTI and Brent, as it will increase the flow from Cushing, OK to Gulf Coast refineries. However, an increase of the WTI price will partly pass on to the Edmonton price too.
 
The Light Oil Access Program is a $6.2 billion project that aims to ease congestion in the US Midwest refining hub and move oil from Canada to the US refineries, adding 400,000 bopd to the current network, effective 2014. The impact from this project on the Edmonton price will be significant. This being said, any proactive investor will now wonder, "Which Canadian companies could benefit much from an increase at the Edmonton price?"

The Beneficiaries

Arcan Resources (TSXV: ARN) is one of the two junior oil producers of the last oil-rich formation in North America: the Beaverhill Lake formation in Canada. The Beaverhill Lake formation is in the Swan Hills Field, which has an estimated 2.9 billion barrels of oil originally in place and has produced 0.9 billion barrels from its discovery in 1957 to year-end 2010.
 
After Crescent Point Energy, which owns 19% in Arcan, PetroBakken Energy is the second suitor that took a big position (17%) in Arcan. Arcan is an oil-weighted "bride" that produces 4,000 boepd (98% oil and liquids). The Enterprise Value (EV) is currently $400 million, so it trades for $100,000/boepd, but well below its book value (PBV=0.28). It has also Proven and Probable (2P) reserves of 35.7 MMboe (Nov. 2012), so the market values its oily reserves for as low as $11/boe. The long-term debt looks high at $300 million, but half of it consists of convertible notes due in 2016. 
 
Apart from the decreasing differential between WTI and Edmonton, a couple of additional factors will play an important role in Arcan's operations, effective Jan. 2013. The big infrastructure investment in 2012 will pay off in 2013, decreasing the corporate operating costs. Arcan has also initiated a low cost waterflood program that can offer a noticeable production upside, increasing the oil recovery factor to 40%. The first results are very encouraging. Two key insiders (VP of Engineering and VP of Production) have also been adding on their positions during the last 3 months.
 
The acquisition of Spartan Oil has been transformational for Bonterra Energy (TSX: BNE), as it strengthens its growth platform and expands its acreage in the Pembina Cardium Pool, which is the largest conventional oilfield in Canada with more than 9.3 billion barrels of original oil in place. The pool is characterized by long-term stable production, high quality oil, and high netbacks. Bonterra is the third largest operator in the Pembina Cardium field.
 
Bonterra (pro forma) has a premium valuation, as it is priced for $125,000/boepd (77% oil and liquids), but it is supported by the consistency of its 7.5% annual dividend, high insiders ownership (25%), and a low D/CF ratio (below 1, pro forma).
 
After acquiring Compass Petroleum and Midway Energy, Whitecap Resources (TSX: WCP) is an oil player with exposure in three liquids-rich formations (Cardium, Viking and Montney) and a production of 17,000 boepd (71% oil and liquids). With an EV of $1.35 billion and Proven and Probable (2P) reserves at 70.7 MMboe, Whitecap's metrics are low as it trades for $79,000/boepd and for $19/boe of reserves. 
 
The company hasn't had any debt problems either, as the D/CF ratio is below 2. The production growth year over year has been strong thus far and things do not seem to change in 2013. Until the market realizes the full value of Whitecap, the shareholders can enjoy a hefty annual dividend of 7% effective early 2013. The low payout ratio of 32% ensures the sustainability of the dividend unless an unforeseen event happens. 

The Spearfish Appeal

Spearfish is a kind of fish which is rarely table fare, appearing mostly in fine restaurants. However, this is also one of the core formations of Legacy Oil (TSX: LEG), which is another very oily producerWith an EV of $1.5 billion and a production of almost 18,000 boepd (85% oil and liquids), it isn't the cheapest company on a per flowing barrel basis. However, it is cheap from a 2P reserves perspective, as its oily reserves are currently valued for only $17/boe. Furthermore, the company has consistent production growth year over year, and an income investor had better put it on his radar, as Legacy will likely initiate a dividend in 2013.

Oil-weighted production growth and dividends are what most investors seek, and Legacy seems to know it. However, it is highly recommended that an investor diversifies his capital and allocates his "dry powder" on all four oil targets above. Putting all the eggs in one basket has rarely been a good investment strategy for high returns.


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